Whistling Past the Graveyard: U.S. Data Improves as the Headless Horseman Lurks

Our Halloween update features improving U.S. data highlighted by the surprising drop in the unemployment rate to 7.8 percent for September. Overseas, it is looking scary. The Gordian knot of Europe’s many problems continues to defy quick solutions. China scrambles to deploy fiscal stimulus as its export markets shrivel. Japanese data is weak. Just down the road we see the Fiscal Cliff lurking like the Headless Horseman of Sleepy Hollow. Headless, because no one in their right mind would design such a massive braking mechanism for an economy that is still struggling to generate forward momentum, as shown by the weak 1.3 percent real GDP growth rate of Q2.

In a recently released report, the Tax Policy Center groups the impending Fiscal Cliff tax increases into six areas: (1) most of the Bush-era tax cuts that were enacted in 2001 and 2003, (2) some of the Obama-era temporary tax cuts associated with the American Recovery and Reinvestment Act of 2009, (3) dozens of other short-term tax breaks that are usually regularly extended, (4) the payroll (social security) tax cut, (5) new taxes associated with the Affordable Care Act of 2010, and (6) the expiration of the AMT “patch”. For most households the biggest impacts would come from the expiration of the temporary cut in social security taxes and from the expiration of the Bush-era tax cuts of 2001 and 2003, which would expose millions of new households to the AMT. A full-strength Fiscal Cliff would increase federal tax collections by $500 billion, or 20 percent, in 2013 according to the report.

The just-completed third quarter promises to show improvement over the second quarter when the preliminary GDP data is released on Friday, October 26. Credit-fueled consumer purchasing (including home and auto sales) is helping to insulate the U.S. from deteriorating global macroeconomic conditions. Real GDP growth for the third quarter is expected to improve from Q2’s anemic 1.3 percent growth rate, to about 3.1 percent. Recharging households are helping to buttress the manufacturing sector against the drag from overseas. A key factor in the sustainability of the U.S. “island economy” is job creation.

September jobs data showed an overall improving view of labor market conditions. Payroll job growth increased by a modest 114,000 jobs in September, slightly better than the original print for August, which was +96k. However, there was a substantial 86,000 combined upward revision to July and August. So we can say that there has been a significant improvement in payroll job growth in the third quarter over the very weak second quarter. But now within the third quarter we see a downward trend…+181k for July, +142k for August and +114k for September. Expectations for job growth in October should remain modest. The unemployment rate dipped to 7.8 percent in September, down from 8.1 percent. This was driven by a huge 873,000 job gain in the household survey for September, following outright declines of 119,000 jobs in August and 195,000 jobs in July. The massive disconnect between the payroll survey and the household survey of employment over the entire third quarter invites a healthy skepticism about fundamental improvement to labor market conditions heading into the third quarter.